Societe Generale analysts Andy Perkins, Peter Knox, and Surendran Panicker state in their research note that Nokia’s slide in revenue is concerning, and the key for 2014 will be to arrest it, with a special emphasis on margins. They reiterate their Hold recommendation.

Nokia

Nokia’s progress in turning around NSN’s infrastructure

In our recent downgrade note (please see here), we applauded Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V)’s progress in turning around NSN’s infrastructure business. Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V)’s guidance for NSN’s Q4 was for operating margins to reach 12%, very high historically for the company and almost certainly higher than Ericsson (NASDAQ:ERIC) is likely to achieve in its Q4 results. Also, the data we have gathered for October and November includes an increase in infrastructure spending in the US (up 9% yoy in October and November) and good Asian infrastructure exports (up 3% yoy), suggesting a robust end of the year. However, NSN will have been adversely impacted by slowing spending in Japan (down 9% yoy in yen, almost 30% in euros), its largest single market. Nevertheless, we believe that NSN will achieve its margin guidance for Q4. We forecast Nokia (excluding handsets) sales of €3.6bn (cs €3.5bn), operating margin of 13.7% (cs 6.9%) and an adjusted EPS of €0.04 (cs €0.05).

Societe Generale view

The key for Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V) in 2014 will be to halt the slide in revenues. The telecom equipment business rewards scale: companies can amortise the very substantial R&D costs over higher revenues. NSN’s Q3 revenue shrank 24% over two years. Consensus expects the telecom equipment market to grow at 2% in 2014 and we expect the growth rate will be even higher. However, to gain revenue NSN will need to gain share. This strategy is likely to lower margins as NSN will have to offer attractive terms to entice operators away from current suppliers. This is by no means impossible. But as Ericsson (NASDAQ:ERIC)’s experience has shown, aggressively bidding for share can leave margins depressed for years. We have already built in lower margins and so we have not altered our forecasts.

How we value the stock

We base our target price of €5.8 per share on a SOTP valuation (comprising NSN €1.9, HERE €0.7, cash €1.7, patents €1.0, tax losses €0.5 ). We therefore stick to our Hold recommendation.

Events, catalysts & risks

Q4 results are due 23 January. NSN will be presenting at the Mobile World Congress on 24 February. The main downside risk to our target price if NSN is extremely aggressive in bidding for new contracts, forcing down margins even further. The main upside risks are if Nokia Corporation (NYSE:NOK) (BIT:NOK1V) (HEL:NOK1V) decides to sell assets. Both the HERE and the IP portfolio could attract a much higher transaction valuation.